Moderated by: Mr Aditya Narain (Head of Equity Research at Edelweiss, India Equity Strategist)
Contributed by: Vikrant Warudkar, CFA
Among other eminent speakers and moderators at the flagship event of CFA India Society, Virginie Maissonneuve, CFA (member of the CFA Institute Future of Finance Council) spoke on“Portfolio for the Future, the new normal is here”. Virginie Maisonneuve (VM), had firstly invested in India in 1990’s, for one of the first foreign investment fund in India.
The presentation carried theme of importance of the ESG factor in portfolios and about climate change, the evolving new normal. It shed light on enough facts and figures, supporting the hypothesis that ‘the climate change is a long-term trend in which companies and governments are evolving’. The presentation discussed purpose of asset management, Disrupters or Shapers having tipping points, and culmination of these disrupting trends shaping decisions of investment managers in portfolio construction. At the start of the presentation, VM urges audience to appreciate the importance of climate change. She also argues that in future, investment management industry have to give options with ESG factors to its clients.
She started the presentation with basic of the Asset Management Industry (AM), where clients seek assistance to achieve their financial goals given the risk. Ethic, trust, sustainability and clarity are additional factors clients seek.Inability of AM to produce alpha at large has paved the way for ETFs, which are now gaining traction in India as well. ETFs are set to cause disruption in the AM ecosystem. Other disrupters mentioned were asset management fees, rate of return (lower for longer), regulation, mass customisation, and ‘Shapers’.VM defines ‘Shapers’ as long term trends having tipping points.
A Tipping points is the critical point in an evolving situation that leads to a new and irreversible development. It is the point at which a series of small changes or incidents becomes significant enough to cause a larger, more important change.Tipping points are difficult to notice or identify since the underline changes are small and gradual. For example, the emergence of China as economical prowess over the decades.The most important tipping point we are facing today is gradual rise in the temperature of atmosphere on the Earth. After industrialisation, the rise in temperature has resulted in the climate change, impacting us significantly. For investors, it warrants inclusion of ESG factors in portfolio construction.
The disruptor’s list also entails technological advances like Artificial Intelligence and Robo Banking. For the coming decades combination of the ‘Shapers’ like Demographics, Climate Change, Technology and share of EM’s in world will continue to shape the world economy. Value creation will come from sustainability and riding the disruption. Asia can remain the centre of the world for coming decades. The growth in the past decades was more based on carbon emission, which is not sustainable, underpinning the need for new growth models. There is consensus among population at large about importance of ESG, and Asia becoming a centre of influence. But positive impact of AM on society has been denied.
Demographics, Technology and the Ultimate Resources
On demographics, the statistics presented are insightful. In spite of a decrease in fertility rate, population of the world is expected to increase, especially of India, China, Pakistan and US. Sub Saharan population to double in 2030 and in future may face migration due to heat. Japan and Europe are facing shrinking population. India is poised to reap demographic dividend. Longevity and ageing will add salt to injuries as pension gap is increasing. India maybecome the highest populated country in 2050. Large numbers of millennial are in China and India. They are tech savvy and respond towards wellness and environment. They question the transparency of media and politicians. The generation Z (born after 2000), referrer of Gig economy, will set the new long term trends. In India, millennial believe in saving and insurance. But they like to take the financial decisions independently. They do believe in sharing economy. Female millennial have strong ambitions. However, millennial have reached their peak of consumption cycle.
- On technology VM has coined an equation:
Brave New World (BNW) = Artificial Intelligence (AI) + Human Intelligence (HI) + Emotional Intelligence (EI)
Higher computing power (Moore’ Law) along with lower Cost of storage has buttressed growth of AI and ML. This has assisted humans to think faster and smarter. Though AI and ML inbuilt technologies have penetrated other industries, Portfolio Management is yet to see the disruption, barring trading with algorithms. Other technologies and their blends for example pattern-recognition, biometrics and neuroscience are proved to be disruptive. Homo Sapience (2.0) needs to adapt themselves to changing sources of alpha by learning soft skills including EI. New era Portfolio Managers need ‘T’ shaped skills which includes soft skills like EI. Board and executive constitutions need a paradigm shift to address the changing environment. It calls for more representation of women, especially in the investment industry.
- The Ultimate Resources
Climate change, the disrupter,was theme of the presentation. As the ultimate resource is the planet and there is no planet ‘B’, we must save this. The Commitments from the governments are shallow and everybody cannot pay equally for the problem. For instance, China and India are larger producers of greenhouse gases; however they have no equal resources to pay for the same.
Person of the year Greta Thunberg says “We can’t just continue living as if there was no tomorrow, because there is a tomorrow”. The next generation has alleged us for stealing their future.
VM explains that climate change is a significant variation in average weather conditions over decades. Rise in temperature causes the change in weather pattern, floods, draughts fire and extinction of corals. Since ice age, sea level has increased by 106 meters, due to the rise in temperature by 5 degree Celsius. Rate of warming of the ocean has doubled since 1993.
Major assets which are at risk includes infrastructures under water (communication cables) ($500 Billion) and coastal shelters. Further, as temperature increases productivity decreases. Heat waves may affect GDP as much as 25% in one day. If, ice at Arctic melts down, not only it will raise the see levels but also release tons of GHG beneath it. Then the process of heating the planet will accelerate. There will be problems of food, shelters, and some part of the worlds may become uninhabitable. Power grids may fail. There are no meaningful actions initiated, but grass route level some steps are being taken. Companies which are not taking actions against the climate change will be punished by the stakeholders or the climate.
India being the second largest coal producer, importer and consumer after China, it needs to shift its electricity generation to nuclear or renewable.A target has been set to shift 40% of present power generation by 2030. Cattles and farming activities are also responsible for emission of CO2 in India.
The ambitious goal of zero emission is still a pipe dream as there is no action from the largest five emitters of Carbon Dioxide. The priority between shareholders v/s stakeholders needs to be decided by adopting the longer-term views.
In the Global economy it warrants for ESG and a sustainable business model with TCFD, financial inclusion and innovation. Collaboration is required to tame Geopolitical tension arising out of the economic fragmentation.
What asset managers need to do to align with the changing reality?
Portfolio management shall reorient themselves for ESG factor, green finance, rigorous measurement and regulation. Alpha generation may happen on the building blocks of ESG.
- Environment– Climate, Resources, Pollution, Waste, Food etc.
- Social – Human Capital, Stakeholders, Slavery, Child Labours, Human Rights, Working Conditions etc.
- Governance – Corporate Behaviour, Transparency, Alignment, Board Diversity and Structure, Taxes and Long-Term Strategy etc.
The managers shall dwell more on the integration of portfolios. More negative screen for ESG factors are required than ever before. Corporate engagement and shareholders actions require more attention. A collaborative approach is paramount of all. The alternative of public-private partnership is required to avoid externalities. Bottom (20%) of ESG stocks have experience larger drawdown (3 times) as compared to top (20%) stocks.
One should look for opportunities in shifting world where there is sustainability in the growth with key themes of security, more with less, sharing on demand, and entertainment / leisure.
- Security– infrastructure, food, water, health, and predictability
- More with less-productivity enhancement (in energy, industry and technology), learning and adaptability, and materials
- Sharing on demand– transportation, consumer
- Entertainment / leisure– virtual, local v/s global
Future portfolios need to adapt to the uncertainties and volatilities generated by the disruptions created by the ‘Shapers’. Over long term, timing the ‘Tipping Point’ is more of art than science, and hence opportunities for alpha generation can be from asset allocation. New skills would be required as the new normal will change. The ESG remains the king.
During Q&A session VM expressed her conviction of for ESG-ETF becoming massive success over next five years, as cost of ETF is coming down. While considering ESG factors, those needs to be taken as average instead of isolated E, S or G. For example, while consuming coal for power generation affecting environment, social issues of workers in coal mines also needs to be taken in to account. Though there is high cost associated with complying for ESG factors especially for mid and small cap companies and large corporates are pushing back the agenda, investors have to think from perspective of having the Tipping Point at a short distance and start investing in sustainable companies. There are huge opportunities in entire space and also PE and VC. Investors will not want to invest in companies which are not going to survive. Companies with more innovative ways for sustainability need to be screened. To avoid abuse of ESG as marketing tool, United Nation Principles for Responsible Investment agreement need to be considered by the firms, which would require reporting. The companies who are not ESG compliant can face difficulties hence there will be a huge demand for ESG compliant investments.A path for adoption of ESG needs to be adopted and scaled up as ‘Tipping’ is long-term and not going to happen tomorrow. Countries like India should use data (structured and unstructured) and AI to use ESG framework more effectively.
VM has suggested two books to the audience to acquire ‘T’ shaped skills
- Mindset by Carol Dweck
- The Uninhabitable Earth by David Wallace-well